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STOCK EXCHANGE: WHY WILMINGTON?

XERXES WILSON AND KARL BAKER, THE NEWS JOURNAL DECEMBER 21, 2015

Delaware Board of Trade officials say they have $7 million of the $8 million needed to be operational in 2016
The group trying to launch a new stock exchange aimed at small- and mid-capped companies didn't know what they were getting into by partnering with Delaware.

On the one hand, they were surprised by quickly getting a personal meeting with elected officials to discuss plans for the downtown Wilmington venture.
But with that came a little more drama and controversy than they wanted.

The executives of Delaware Board of Trade Holdings Inc. said they are negotiating a 15-year lease for space at 800 Delaware Ave. and have $7 million of the $8 million needed to be operational in 2016, pending regulatory approval.

"It is a tipping point. Once you get funding from different sources, others get more comfortable with the venture," said Dennis Toner, one of the project's managers and a former longtime aide to Joe Biden in the U.S. Senate, and as vice president. "Nobody likes to be the first one in."

That doesn't mean the process hasn't been rocky, even for a group of high-profile financial executives with extensive résumés.

The News Journal this month met with Toner and five other exchange officials for nearly two hours, their first time speaking at length about the plans and the company,which was incorporated in June. The group for months has been holding closed-door meetings with private financiers and some of the highest-ranking officials in local and state government.

Their pitch is to create a new kind of all-electronic trading system, with a Delaware twist. The plan calls for two trading venues – one handling transactions of U.S. and foreign securities with a value of at least $20 million, and another for small- and medium-sized businesses.

They say the advantage of locating here is that Delaware already is the legal home to about half of U.S. publicly traded companies, which flock to the state to incorporate because of low taxes and the Court of the Chancery that handles disputes involving corporations.

Supporters envision branding Wilmington as a place where capital is accessible for businesses not big enough to trade on the New York Stock Exchange, Nasdaq and Standard & Poor's 500 index.

Officials say start-ups could incorporate in Delaware and then become listed on the exchange, creating a one-stop-shop for new businesses in search of funding. Another advantage the state has is that it's loaded with high-capacity fiber optic lines that can send stock data quickly to the Greater New York area, has plenty of rail connections and is one of the most affordable areas on the East Coast.

"If you're coming here to get capital, to get listed, look how inexpensive our downtown is for being on the Northeast corridor and right on the Amtrak rail line. We have a lot of attributes," said Tom Ross, a former chairman of the state Republican Party hired to serve as a spokesman for the project.

The exchange the first year is projected to hire up to 50 workers paid an average $136,000 annually, and eventually up to 125 making an average of $86,000.

Board of Trade CEO John F. Wallace, a former chief executive of the Philadelphia Stock Exchange, said they're working to bring the same level of transparency of large exchanges without the regulatory hoops that prevent some companies from listing on places like the New York Stock Exchange. Some seek capital by getting listed on smaller stock exchanges that don't have the same regulations.

Under the Board of Trade's plan, companies will have to submit annual audited financial reports, which investors will be able to view on the exchange website. However, they would be exempt from more complex financial disclosure rules, called Sarbanes-Oxley, enacted in 2002 to provide additional shareholder transparency following the collapse of companies like Enron and WorldCom.

Wallace said the less-burdensome rules give small companies breathing room as they grow. Officials are still determining the minimum amount a company can be worth before being allowed on the exchange.

"We're the farm league bringing companies up," Wallace said. "For us, the success story is when we march a small company that started up on our venture and take them up and have them do a bell ringing up on the New York Stock Exchange or the Nasdaq."

Wallace said they initially will build the business on trading existing U.S. and foreign companies, then focus on attracting startups, with the goal of that segment being the biggest within five years.

Fees companies are charged to list on the exchange will be the largest revenue stream after its first year, according to a planning document submitted to New Castle County this summer. Transactions for trades will also be a major part of the organization's revenue stream in its initial year, according to the document.

However, generating money through trade fees may be difficult, said Michael Wong, an equity analyst with Morningstar, a financial services firm. He said shares of small- and medium-sized companies "lack liquidity," meaning their shares trade much less often than those of larger companies because there isn't as many willing buyers and sellers.

"If you are specializing in liquid markets, the aim would not be to make your profits or revenue off of trading activity," Wong said.

To be successful trading smaller companies, an exchange must form partnerships with larger brokerages that will sell a sufficient number of small- and medium-cap business shares in order for trading to move smoothly, Wong said.

Wallace said those partnerships can be struck if the Delaware Board of Trade "cleans up" the current over-the-counter trading market.

"Customers want to see what you get. They want it to operate like the New York Stock Exchange. There is a lot of unease. I've talked to large firms where they discourage people trading in the over-the-counter market. They say if we can build this and there is transparency, they will be there," Wallace said.

The heavier regulation found with traditional exchanges leads to higher costs for companies, but buyers and sellers in those venues also can be confident that the price they get is the same one everyone else is paying at a given time. That is the price of transparency Wallace wants to bring to his exchange.

Wallace said buyers of shares on the over-the-counter market too often don't see what price others are paying because dealers don't have to immediately to post bids. His exchange will function more like a traditional exchange where the lowest offer price is matched with the highest bidding price.

Paul Gulberg is an analyst with Portales Partners in Manhattan and said the Wilmington model is the first of its kind. It is largely untested, he said, but that doesn't mean it won't be successful.

He said there is a need for an exchange that offers a central place for small companies to list and trade shares openly for everyone to see – like a small scale NASDAQ. But the challenge will be for the Board of Trade to make enough money from those trades.

Most investors, Gulberg said, won't want to spend the time studying each small company and therefore will avoid the shares altogether. There will be some who simply want to bet on various venture firms – like placing chips on red or black at a roulette wheel – but that may not be enough trading volume for the Board of Trade to make money.
Manhattan-based OTC Markets will be one of the proposed exchange's primary competitors. The company lists 10,000 securities that include large foreign firms like Heineken and Adidas. The company also lists small companies with little disclosure and oversight.

OTC Market CEO Cromwell Coulson said trading is not a "country club sport." Small companies fail and buyers and sellers are not friends. That's the 'American way," he said.
"If you look at what successful venture markets are, the good companies are great, but a venture market is a place where a lot of companies are going to fail and that is fine," he said.

But Wallace said the Delaware exchange will be a cleaner version with higher standards for who can list.

OTC Markets doesn't decide which companies are good and bad, Coulson said. Rather, they identify a company's quality by the amount of financial information it posts for investors.

Last year, Cromwell's company, which is publicly traded, took in $50 million in revenue. That's where the Delaware Board of Trade wants to be in five years.

"The more successful we become, the more people would like to compete with us," Cromwell said. "Building a venture market, building an international market, building a market for securities that need liquidity is not easy."

SEEING AN OPPORTUNITY

Wallace said the genesis of the Delaware plan was the federal Jumpstart Our Business Startups Act. Part of the legislation, which President Barack Obama signed in 2012, allows small companies to sell as much as $50 million in shares in a year, without having the same regulatory and reporting rules as going public. The law was intended to provide a new pipeline for capital and kicked in this year.

Wallace said they saw an opportunity in the new rules, and the executive team eventually grew to include Richard Niehoff, who led the Cincinnati Stock Exchange's transition to a fully electronic trading platform in the 1980s, as president and CEO. The organizers in May discussed developing the exchange in Austin, Texas, home to numerous start-ups and a sizable venture capital environment, but were persuaded that Delaware was the better option.

Director of Operations Dennis Boylan said they held meetings with Gov. Jack Markell, all of the congressional delegation and New Castle County and city officials. Boylan was a manager for the Philadelphia Stock Exchange, which was acquired by Nasdaq Stock Market in 2007, and said he immediately noticed a difference in dealing with Delaware officials.
"When we came down here, we met the governor, the two senators, the congressman, the city officials, everybody very quickly," he said. "In Philadelphia, it's not (like that)."
They've received support from New Castle County Executive Tom Gordon and Wilmington Mayor Dennis P. Williams, who has said the exchange could provide important jobs and spark economic activity downtown.

Part of the pitch to government officials was the involvement of Richard Grasso and Joseph Grano – two marquee names in the world of finance who lent additional credibility to the project. But controversy over the public funding of the project caused the two to pull their names from the venture last week.
The city is also exploring a funding plan for the stock exchange involving the city-run Wilmington Urban Development Action Grant Corp., which would provide an $800,000 loan to a business incubator called the Emerging Enterprise Center, run out of the New Castle County Chamber of Commerce. The center would combine the loan with $600,000 raised from the federal New Market Tax Credit program, designed to increase business investment in low-income communities.

Another $600,000 would come from Discover Bank, which may be able to donation to meet its obligation under the federal Community Reinvestment Act to help economically struggling areas.
Matthew Parks, director of Discover Financial Services, said it all depends on whether the exchange is on stable footing.
"We've been asked to provide them with some technical assistance grant money and some grant money for them to make an investment," he said. "It's potential. It's all predicated on a lot of pieces coming together."

Together, the city and county packages make public financing the largest source of funding for the project. No state incentives are being provided.
Bob Older, CEO of the Delaware Small Business Chamber, questions whether too much public money is in play. He said the success of the Board of Trade will depend on whether the exchange fees are affordable enough for small businesses to join and if they see an opportunity for generating money outside of banks.

"Without knowing all these rules and exactly what they are going to do, it is really hard to say whether it is going to be good or bad," he said.
Older said government "is giving money to this thing without knowing the rules and regulations."

"If they city wants to contribute to business, there are plenty of organizations to help," he said.

Ross defends the use of public money, saying it was critical to give the exchange stability before private funding kicks in. At this point, the project is built on having that initial cash flow, he said.

"Once you pull the foundation of the capital stack, everything goes wobbly," Ross said. "Our investors are still confident. We are moving forward."

Despite the controversy, Gordon said he stands by the public investment because of the project's potential to create jobs.

RIBBON-CUTTING EXPECTED THIS MONTH, OFFICIALS SAY
The funding arrangement is being closely watched as the project enters the final fundraising phase and awaits approval from the Securities and Exchange Commission and Financial Industry Regulatory Authority.

Officials would not discuss how many companies have expressed interest about being listed or an exact date of when the exchange will be fully operational. They said advanced negotiations are underway to lease space at 800 Delaware Ave., hoping to have a ribbon-cutting before the end of the month. The building, on the western edge of downtown, would house various technical positions to maintain the network, as well as the website that will profile companies and provide financial details.

Employees also will handle marketing to brand Wilmington, the officials said. Part of the proposal includes having live updates from the exchange, similar to those seen from Wall Street.
Boylan said a key piece will be reaching out to companies to be listed.

"There is a large component of employees that will be responsible for going out and making the pitch to get companies," he said. "That is part of our business model to go out and bring them in. We have to vet them."

They also plan to work with the Delaware Small Business Development Center in Newark, which provides training and resources to established firms and startups, to identify who could be listed.
The venture has support from Mike Bowman, the Development Center's director. He said Delaware has many positive business attributes, but lacks a large pool of investment capital for small companies. Venture capital outfits in other states draw businesses away, he said.

If the stock exchange successfully arises in the backyard of Delaware's small companies, they should be able to more easily find the money to grow, said Bowman, who previously was the chairman and CEO of the Delaware Technology Park in Newark.

"It would be nice if Delaware were the first mover on that like they've been the first mover on many other things financially," he said. "So we're kind of exciting to see if in fact this can play out or not."
Kirk said most of the funding for his company, which makes conferencing technology, comes from wealthy individuals who see enough promise in the business to help fund it. Finding money at a bank or venture capital outfit is difficult, he said, because his company is building a product that targets businesses as customers, and not the general population.

Kirk, who is not affiliated with the new exchange, said he decided to relocate to Austin, Texas, next year partially because of the availability of capital in the area.
"I still believe in fostering Wilmington's tech ecosystem, but it is not making business sense," Kirk said. "We did everything we can to make it happen in Wilmington, but it was an uphill battle."

If the Delaware exchange finds success, Wilmington can establish itself to the rest of the country. Wallace said the state offers both proximity to Wall Street computer servers while being removed from the culture. For many companies, New York bankers share too much of a resemblance with investors on the reality show "Shark Tank," he said.

"We know out on the West Coast they do not like the New York financial markets," Wallace said. "We think we can sell Wilmington."
The board is betting both their time and public dollars on the project's success.

"It's not just like check the box and open," Ross said. "We're talking about a long-term commitment to Delaware and a long-term commitment to downtown Wilmington."

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